Wednesday, April 4, 2018

CorePoint Lodging: Form 10 Notes

Today I'm doing another update, this time on La Quinta's upcoming REIT spinoff, CorePoint Lodging (CPLG), based on the long awaited update (at least on my part) to their Form 10 and the merger agreement between La Quinta (LQ) and Wyndham Worldwide (WYN).  Quick recap, La Quinta announced last year their intention to separate the hotel management business from the real estate, initially that was a straight forward spinoff of the real estate into a REIT, but Wyndham came along and offered to buy the management company for $1.95B in cash.  Later in Q2, La Quinta shareholders will receive $8.40 per share from Wyndham for the management company and shares in the REIT spinoff, CPLG.

The setup for CPLG checks off a lot of boxes, it's likely to sold/trade cheaply as a taxable spinoff, plus it will have the dual benefits of EBITDA growth and a multiple that needs to come up.  When I've gotten in trouble with spinoffs or just special situations in general, its usually because the spinoff is a dressed up melting ice cube, I believe the opposite is true in CorePoint's case.

CorePoint will have 317 hotels with over 41,000 rooms across the United States (all of LQ's international hotels are franchised or managed) and is positioning itself as the "only public REIT focused on the midscale and upper midscale self-service lodging segment."  That's more happenstance than design, but self-service hotels feature more consistent and wider margins than their equivalent segment full-service competitors (fewer employees, 99% of revenues from room rentals).  On the negative side select-service hotels are viewed as easier to build, CorePoint pointed to the fact that midscale hotels are the fastest new build segment (its pitched as a positive), that's good for Wyndham has a management company but likely bad for operators like CorePoint as more suppy comes onto the market.  The majority of their hotels are located near suburban office parks, airports and along interstates, mostly avoiding urban and resort locations that could be more impacted by AirBnB and HomeAway like room sharing services (but again, easier to build new supply in suburban locations).  As a REIT, CorePoint technically can't operate the hotels under the typical franchise arrangement Wyndham uses and instead the hotels will be managed by Wyndham for a 5% of revenue fee (plus your typical royalty, reservation, and marketing fees you'd see in a franchise arrangement).

Quick screen shots from the Form 10, listing the locations and chain scale, much of the economy bucket is exterior corridor hotels that they've been selling off in recent years, but as you can see, a reasonably diversified hotel base for a one brand REIT.
At the time of my brief post on the idea in January, we didn't know the proforma capital structure at CorePoint and it muddied up the valuation a bit.  CorePoint is taking out $1.035B of CMBS financing that is secured by their hotel properties and then paying a dividend to LQ/WYN of $983.95MM subject to the adjustments listed below from the Separation and Distribution Agreement:
Section 3.6. Cash Payment. Upon the completion of the Financing Transactions and immediately prior to the Effective Time, CPLG shall transfer to LQ Parent or the applicable member of the LQ Parent Group, as directed by LQ Parent, an amount equal to $983,950,000, as such amount may be adjusted pursuant to this Section 3.6, such amount of which will, substantially concurrently with the Distribution and the Merger, be used by LQ Parent to satisfy a portion of the Liabilities outstanding under the Existing Debt Agreements; provided that:
(a) in the event the Closing Existing Net Indebtedness exceeds the Estimated Existing Net Indebtedness, the Cash Payment shall be increased on a dollar-for-dollar basis by the amount of such difference;
(b) in the event the Estimated Existing Net Indebtedness exceeds the Closing Existing Net Indebtedness, the Cash Payment shall be decreased on a dollar-for-dollar basis by the amount of such difference;
(c) in the event the amount of accrued but unpaid Transaction Expenses as of the Distribution Date exceeds the Estimated Transaction Expenses, the Cash Payment shall be increased on a dollar-for-dollar basis by the amount of such difference; and
(d) in the event the Estimated Transaction Expenses exceed the amount of accrued but unpaid Transaction Expenses as of the Distribution Date, the Cash Payment shall be decreased on a dollar-for-dollar basis by the amount of such difference.
The Estimated Existing Net Indebtness is listed as $1.665B in the agreement, as of 12/31/2017, LQ had net debt of $1.53B, reducing CPLG dividend payment down to ~$850MM.  The cash position at the time of the spinoff will then be something in neighborhood of ~$185MM ($1.035B - $850MM).  Proforma CorePoint earned $208MM in (adjusted) EBITDA for 2017, using my previous 12x multiple, gets me to about $14/share for CPLG.
$14 + $8.40 from WYN when the deal closes, gets you to $22.40 per share, or put another way, the market is currently valuing CPLG at a little under 10x EBITDA (no internally managed lodging REIT trades that cheap) at today's $18.84 share price.

Sources of Upside:
  • The cash balance will likely be higher than $185MM, we should assume some additional cash build from the beginning of the year until the deal closes (although maybe not due to rebuilding efforts after the hurricanes).  Plus as part of the Tax Matters Agreement, CPLG will receive any excess between the actual tax due and the $240MM amount Wyndham agreed to escrow as part of the management company deal.  I can't quite figure out what the cost basis is for LQ itself (I saw an analyst note that pegged it at $1.7B but can't source it for myself) so if you know what the amount is, please let me know.  Let's say that $1.7B is correct and my EV on the first day is correct at $2.5B, the Tax Matters Agreement assumes the tax rate at 24.65%, which would be about ~$200MM of the gain, meaning $40MM could come back to CPLG and potentially more if really trades down day 1 (most likely as I doubt it'll trade at 12x EBITDA to start).
  • This will also be taxable for shareholders, your taxable gain will be $8.40 + CPLG's first day price over your own tax basis, so all current LQ shareholders (including 30% owner Blackstone) should be cheering for the shares to get dumped the first day and then hopefully recover once the proforma numbers are clearer.
  • The spinoff is maybe ~2 months out and we don't have a CorePoint specific shareholder presentation, I haven't seen a lender presentation (which makes sense since they went the CMBS route) or heard about a road show, maybe there has been one but its certainly under the radar, it seems pretty clear to me that management isn't going to try and pump the stock up ahead of time.
  • This is quite the interesting dynamic where the lower the price, the better for everyone involved, management appears to know this and hasn't put out any forward guidance for the spinoff leaving the market to anchor to 2017's numbers.  2017's numbers could be deceptively low for three reasons: 
    1. The 2017 hurricanes significantly impacted La Quinta's owned hotels in Florida and Texas, in Florida more than 3000 rooms were out of service for the last four months of the year, and as of 2/28, 5% of CPLG's rooms remain out of service as they undergo repairs.  They disclosed a $36.7MM revenue impact due to Hurricane Irma closures in 2017, and on the Q4 call translated this into an annualized estimated EBITDA loss of $28-35MM (to be recouped through insurance proceeds which should add to the cash balance as well).  This could be a short term risk to the stock price depending on how quickly their Florida hotels get back online, but eventually the insurance proceeds will come in and the hotels will reopen.
    2. LQ initiated a big capex program in late 2016, they identified 50 hotels to renovate with the hope to move them from midscale to upper-midscale and capture greater room rates.  With this renovation project, many hotel rooms were out service and are just now re-opening, the renovation project cost $180MM and is expected to be largely complete by the time of the spinoff, what return will that investment make going forward?  On the Q4 conference call, managemend stated that remodeled hotels had on average a 13% increase in RevPAR upon reopening.
    3. La Quinta has always been a standalone brand without a larger rewards group.  La Quinta Rewards has 15 million members, by joining Wyndham Rewards and their 55 million members, WYN will funnel more travelers to CorePoint's properties.  They'll also potentially see some margin benefits from shifting a few percentage points away from OTA's to their direct reservation sites being part of Wyndham.  Additionally, there could be some opportunity to rebrand some of CorePoint's La Quinta hotels that are upscale or on the high end of the upper mid-scale segment to one of Wyndham's upscale brands.
  • Let's pretend forward EBITDA is closer to $235MM for 2019 (hurricane recovery, renovated hotels coming back online at higher rates and WYN synergies) CorePoint could be worth over $16 per share, or over 50% upside from today's implied price.
Other Thoughts:
  • I've received some pushback on this idea due to the "one brand" risk, however with a hotel REIT, I think some of that risk is overblown.  CPLG as a hotel REIT is not taking the credit risk of LQ/WYN unlike some of the triple-net lease REITs that were spun off with one master lease tenant.  Hotels change the logo on the outside of the building not infrequently; brand diversification makes for a nice investor relations slide but how important is it really?  Quick service restaurant franchisees usually specialize in one brand, although Papa Johns franchisees maybe wished they also own Dominos stores, I think of the hotel REIT business similarly, more about locations, markets and value/price over single brand risk.
  • CorePoint will have geographic market concentration risk, 23% of their hotel rooms are in Texas which caused the stock to drop significantly during the oil downturn in 2014-2015, and more recently their concentration in Florida resulted in significant disruption after Hurricane Irma.  Mr. Brightside, both markets are recovering and should provide a tailwind to CorePoint's results post spinoff.
  • There will be a 1 for 2 reverse split ahead of the transaction, keep that in mind when it actually starts trading, my $14 estimate becomes $28.  In the Form 10, a purging dividend is mentioned but its expected to be minimal.
  • CorePoint mentions they intend to be an acquirer, initially that seemed strange, but given the potential cash position at the spinoff, it might make sense to play consolidator for a minute in the fragmented midscale segment (another source of growth).  Either way, with the spinoff being taxable and the presence of a 30% private equity owner, I'd expect CorePoint to be acquired in relatively short order (6-24 months) after the spinoff.
It might be better to wait for the spinoff to occur and get some more color around the Florida hotel recovery speed before diving in but I have a position now and expect to add to CPLG when it begins trading.

Disclosure: I own shares of LQ and WYN (plus WYN calls)

38 comments:

  1. Your 2nd paragraph on melting ice cubes: you can apply the classic "Munger helped Buffett see the virtue of quality" to spinoffs. Hilton Grand Vacations(HGV), best-in-class, high ROIC, 25 yrs of uninterrupted growth, was never written up on VIC. I wonder why. My guess is over-focus on cheapness over quality. For spinoff investors, HGV has been very satisfactory so far.

    ReplyDelete
    Replies
    1. Yes, I liked HGV from the spinoff and its seen significant multiple expansion, I made some money off of it, but should have owned more, think we might see a smaller version of that with WYN soon.

      Delete
  2. MDC which call strike/expiry. Thanks

    ReplyDelete
    Replies
    1. For WYN, I own the $115 Aug calls.

      Delete
  3. Hi, thanks for your notes. How does the spin off being taxable and the 30% PE ownership make CP a more attractive takeover target? Thanks!

    ReplyDelete
    Replies
    1. Since its taxable, there is no two year safe harbor period on the tax-free aspect of a typical spinoff, usually companies wait two years (if you don't, there's a hurdle involved to prove you weren't in talks prior to the spinoff). Then with Blackstone, pure speculation on my part, but they'll already be taking a capital gain in 2018 due to the spinoff, they're not forever long term holders, they could do a secondary and get out like HNA has been doing with HLT/HGV/PK but I'm guessing Blackstone could get a better price in a takeover scenario since I doubt CPLG trades at a significant premium.

      Delete
  4. First of all, thank you for all your fantastic insight on this blog. You’ve opened my eyes to how to do great analysis for special situations.

    Just curious, if you only had a bit of extra cash to invest, would you prefer owning La Quinta or Wyndham before the spinoffs?

    ReplyDelete
    Replies
    1. Thanks for the kind words. If I had to choose I'd probably own WYN before the spinoff as with LQ you're receiving a fixed amount of $8.40/share for the management company, but I can envision a scenario where CPLG sells off and creates a great opportunity after the spinoff.

      Delete
  5. Hi MDC - great post as always, I actually created my blogger profile mainly because of this post. Had a few quick questions:

    First, is EV/EBITDA the best multiple to use to value a REIT? I was definitely attracted to the cheap price, but have you looked at it on a P/FFO or P/AFFO basis compared to other REITs? Not too familiar with the real estate space though.

    Second, have you looked into the legal restrictions on REIT status? From what I understand theres a slight chance that CPLG may not be able to spin off as a REIT and instead have to wait a while before reattaining its status, due to its recent IPO and the 5 year minimum restriction. Seems to me this may depress share price and hopefully lead to more upside as income investors shy away at the start.

    Third, how high do you think the odds of an acquisition are? and if so, what are some potential players that might be looking at CPLG. From what I understand, are you saying that because the spinoff is already taxable, theres no need for an outside acquirer to wait the two years out to save money on the taxes? Also, I think Blackstone has been holding LQ since 2005 - would they be looking to liquidate now?

    Overall, I'm really liking this special situation. Thinking of picking up some CPLG stock right after the spinoff to take advantage of lower prices - do you think that would be the best way to take advantage of the value mispricing?

    ReplyDelete
    Replies
    1. 1) Hotel REITs are more like operating companies (taking the business risk here) than pure REITs so I think the EV/EBITDA approach is better and commonly used by the analyst community. P/FFO suffers from many of the same drawbacks as P/E, highly leveraged companies are going to look cheap.

      2) This sounds vaguely familiar, did I miss it in the form 10 or another document? I believe most of the REIT restrictions the IRS put in place were on tax-free REIT spinoffs, basically they're no longer allowed, but since this is a taxable spinoff I don't believe there should be any issues becoming a REIT?

      3) There are 20+ hotel/lodging REITs that are public, I don't have a shortlist of who would be the most likely acquirer, but I imagine it would make sense for many of these to take a look. Yes, the odds of an acquisition are higher because CPLG won't have the two year safe harbor issue, some spinoffs are able to get around this and be acquired within the two year time frame, but that's not a concern here. I can't really speak for Blackstone, don't have any inside knowledge there or know if they have a liquidity date in mind, but I would imagine the easiest way to dispose of a 30% stake in a small cap REIT is to encourage the board/management to sell the company. I think the odds are pretty high it gets acquired, maybe 50/50 within 2 years? It's not my primary reason for liking this idea, but I was interested in the CUZ/PKY spinoff last year (or might have been 2016), PKY was the taxable REIT spinoff and was acquired ~6 months later by a Canadian pension fund.

      I think waiting is probably fine, I own a decent size position, but will be looking to flip my $8.40/share in cash from WYN into more shares of CPLG if it trades cheaply.

      Thanks for reading, commenting, and the kind words.

      Delete
    2. Thanks for the well written writeup MDC!
      I am not very familiar with REIT spinoffs and am used to tax free spinoffs so my question is -
      Given that all REIT spinoffs are a taxable, aren't all REIT spinoffs give management the incentive to have spinco trade at a low valuation initially?? What's different about this REIT spinoff in that regard?

      thanks in advance!

      Delete
    3. I don't think there is a difference. I don't have any numbers to back it up, but I'd guess there have only been a handful of taxable spinoffs in recent years, it's rather rare although might be less rare now that all REIT spinoffs are taxable (the IRS rule is only 1-2 years old). Before many of the opco/propco splits included an "active trade business" or jokingly referred to as a lemonade stand with the REIT to qualify for tax free status. For instance, the HLT REIT spinoff PK has a small laundry service business to make it qualify as tax free. I'd say the difference isn't related to just REIT spinoffs, but spinoffs as a whole, you can occasionally infer management's intentions on a spin by how much they dress it up prior to regular-way trading.

      Delete
    4. MDC, in advance of my question / comment, your blog is awesome. Thank you for all that you do. Keep it up!

      On valuation, I am not sure why AFFO doesn't matter when nearly all the lodging REITs are huddled around 11x-12x AFFO with ~4x leverage. It matters for CPLG bc their AFFO/FFO ratio is 60% vs 80% for peers. Cost of roof, dresser, rug is the same, but LQ's REVPAR is way below so maintenance capex as % of revenue / EBITDA is much higher than higher REVPAR peers.

      Delete
    5. Thanks Teton, I'll try my best to keep it up.

      Can you help me with your AFFO? Are you subtracting maintenance capex from FFO? Just looking at 3-4 of the lodging REITs and as far as I can tell they're not doing this in their FFO to AFFO bridge. Could you pick an example?

      Because otherwise, on a basic FFO, I get around the same valuation, FFO would be about $150MM TTM (EBITDA - $50MM in interest on the CMBS), x 11 and that's a $1.6B market cap.

      You might very well be right on the maintenance capex as a % of revenue, the company touts the opposite in their filings, but I'll admit I didn't comp it to full service peers as I assumed it was correct as its one of the selling points of a select-service model. Don't have to upkeep all the extras.

      Delete
    6. They typically disclose in the K. Lodging REITs a bit different from traditional office, retail, etc in that regard. For example, RLJ is 5% of rent, PK is 4%. There seems to be strong correlation between REVPAR and this ratio. It makes sense given that a lot of the recurring costs, carpeting, roofs, doors, etc are commodity-like and if you spread over higher rate charged, your FCF conversion will be better.

      I think the proper math is the same FFO plus a deduction of ~$70m-$75m for recurring maintenance capex (8.5% x $820m in owned rent), getting you to something in the $75m range for 2017. This is the cash available for dividends etc. On this metric, higher asset quality peers are trading at 11x-12x and they are tightly wound around this number.

      Delete
    7. Thanks -- On the same page, that's more of a FCF yield than an AFFO yield? At least as reported, when I was looking earlier I was seeing lodging peers trading for 11-12x TTM "AFFO" which wasn't including ongoing capex, I wouldn't think hotel REITs would trade 8-10% FCF yields as a group? But I'll take another look. Good point on commodity-like ongoing expenses, curious how that nets against not having bars/restaurants, pools, etc.

      Delete
    8. FCF = AFFO in REITs. AFFO adjusts for straight line rents, maintenance capital, etc. Perhaps hotels are due for a rerating, but that is where they trade. Please tell me if I'm off because I like the "situation".

      Delete
    9. Let's take PK for example, 2017 EBITDA was $757MM and AFFO was $596, difference is mostly the $124MM interest expense? I don't see maintenance capital being removed in the FFO to AFFO bridge they provide in their press release. Using your 4% of revenues number, maintenance capex should be ~$110MM annually? I know typical convention is to subtract maintenance capex from AFFO for REITs, but I don't know if that's the convention for lodging REITs? PK is trading for 11x their AFFO, but if I'm right and they're not subtracting for maintenance capex, then you get about to the same place for CPLG at $14/share. CPLG should also have increasing AFFO going into 2018, whereas PK is projecting flat to slightly negative.

      Delete
    10. *going into 2019, 2018 results might be a rocky at CPLG.

      Delete
    11. Lodging REIT AFFO is really just FFO. What I'm saying is that REIT investors look at AFFO as FFO less maintenance capital expenditures (not totally sure why lodging REITs tend to disclose in K). PK's 4% is 8%-9% for CPLG. It's the same argument that a person wouldn't pay the same EV/EBITDA multiple for 2 companies that had identical EBITDA margins / revenue growth rates, but significantly different capital intensity. You'd put a higher multiple on the low capital intensity business and to compare, you'd probably do something like an EV / (EBITDA - CapEx) multiple to put them on an apples-to-apples basis. Again, I am not 100% here, but it strikes me as overly loved by event guys that aren't looking at it like a REIT investor would. Maybe I'm misreading?

      As an aside, PK is probably a bad comp because their REVPAR is $170 vs LQ at $50.

      Delete
    12. Yes, that's fair on PK, I more was illustrating that AFFO isn't FFO in those 10-12x multiples. Didn't know it was overly loved, but sure, have to think about it from a REIT investor point of view, what's the sustainable divided? I guess that points to your FCF argument again. Thanks, good discussion.

      Delete
    13. Really appreciate the discussion. Looks like lodging REITs now are at 10.5x FFO (I know lodging companies call it adjusted funds from ops in press releases) and 12.5x AFF), with obvious variability between best-in-class and not.

      Delete
  6. I'm guessing part of Teton's "overly loved" has to do with recent Sohn award:
    http://www.sohnconference.org/wp-content/uploads/2018/04/AWalker_CorePoint-Sohn-Pres-vFinal.pdf

    ReplyDelete
    Replies
    1. That was a really good presentation

      Delete
    2. There is a fuller write-up on the guy's blog. Hits a lot of the same points as MDC and gets to similar $.

      http://www.yetanothervalueblog.com/2018/04/corepoint-la-quinta-ira-sohn-contest.html

      Delete
  7. Hurricane risk: I think we need to be a little careful thinking 2017 was a one-off year. Florida gets hurricanes most months. Unlike earthquakes, hurricane occurrence and frequency can be predicted with some accuracy (severity and directional change are more difficult to predict). 2018 is predicted to be an active year for hurricanes in Florida:
    http://www.tampabay.com/hurricane-guide/Watch-out-Florida-Forecasters-predict-active-2018-hurricane-season_166989625

    ReplyDelete
    Replies
    1. That's fair. I'm also a little nervous about full year 2018 numbers, they're going to be a little rough and noisy, is that market going to look through that to 2019? Not sure, might create a short term trading opportunity too.

      Delete
  8. Another interesting anecdote - In both the Q1 2018 and Q4 2017 earnings calls no analyst questions were allowed. That is despite the fact that the Q&A part in Q3 2017 was very active.

    Made me wonder if that is also a part of management's efforts to depress the price.

    ReplyDelete
  9. Another positive tidbit, the current LQ CEO and COO along with many other current LQ directors will be siding with the spinoff...may play into the efforts to depress the price

    ReplyDelete
  10. I sold today at $28 which was my price target here and back in January. Might revisit if longer dated options start trading on it soon as a way to hedge against remorse if this gets bought out soon.

    ReplyDelete
  11. Did everyone receive the $8.40 per share in cash? I thought it was supposed to happen when CPLG spun off but I haven’t yet received the cash and was wondering if I missed something. Any insight would be greatly appreciated.

    @MDC - thanks for all you’ve given to this community and for all your insights!

    ReplyDelete
    Replies
    1. Thank you, and I did receive my cash this morning.

      Delete
  12. any thoughts post the print and sell off?

    ReplyDelete
    Replies
    1. I think it looks interesting again, I thought 2018 numbers could be rough and that it's really a 2019 guidance story once the major capex project and hurricane repairs are complete. If you add back the hurricane impact, they're looking roughly flat year over year, so not as terrible as it might look on the surface. I'm thinking about re-entering, just makes too much sense for these guys to get taken out at some point.

      Delete
  13. That’s where I’m shaking out also though I’m surprised given the incen I’ve they had to keep it low into the spin they’d effectively disappoint on this call. That said there was so much noise in the report and so little coverage in general volatility is to be expected

    ReplyDelete
    Replies
    1. I bought some January calls, might be dumb, should have waited for longer dated strikes to start trading, but yes, seems like an overreaction to me.

      Delete
  14. Any thoughts on CPLG at ~$19?

    ReplyDelete
    Replies
    1. I haven't had many new ideas recently, but I do like CPLG here, I think last quarter was essentially in line with where expectations should have been, my concern was around 2018 numbers and the lack of guidance heading into the spin, still believe this is a 2019 story once last year's hurricane impact is mitigated and the capex project is completed. I bought some calls as mentioned above, that was probably another bad decision, but I like the stock here, might just be simple and buy.

      Delete